Power Talks: Budget 2019 – An Assessment

Macro-Economic Background to Budget 2019

Budget 2019 was the third and possibly the final budget to be presented by Paschal Donohoe in the current Dáil. As was the case with his last two budgets, Budget 2019 did not pose anything like the sorts of challenges and difficulties that his two immediate predecessors faced in framing fiscal policy. The fact is that the Irish economy is in the midst of a strong economic recovery and the public finances are steadily moving into a better place, but there is still a distance to go and there are still many challenges to overcome.

The economic and fiscal background against which Budget 2019 was presented is quite positive. The Irish economy continues to perform strongly. Recent data from the Central Statistics Office (CSO) confirms that in 2017 real Gross Domestic Product (GDP) expanded by 7.2% and real Gross National Product (GNP) expanded by 4.4%.

It has been well documented that the measurement of Irish GDP is complicated by the activities of the multi-national sector, aircraft leasing and the treatment of intangible assets such as Intellectual Property (IP).

In recognition of these difficulties, the CSO has developed an alternative national economic indicator called modified Gross National Income (GNI) or GNI*. This is defined as GNI less the impact of re-domiciled companies and the depreciation attributable to relocated capital assets. In effect, the new indicator seeks to exclude the globalisation effects that disproportionately affect the measurement of the size of the Irish economy. This measure gives a more realistic assessment of what is really happening in the economy.

In 2017, GDP stood at €294 billion. However, modified GNI or GNI* stood at €181 billion or €113 billion less than GDP. These different measures of economic activity complicate interpretation of what is really going on in the economy and more importantly, the prudent and appropriate stance of fiscal policy.

A significant challenge is presented by the fact that the inflated nature of Irish GDP puts an artificially positive slant on the public finance parameters. At the end of 2017, Ireland’s government debt was equivalent to 68.4% of GDP, which is just above the Maastricht Convergence debt target of 60%. However, if a more realistic assessment of Ireland’s real level of economic activity is made, the debt to GNI* ratio stood at a high level of 111%.

The real level of debt is still dangerously high and prudent management of the public finances is essential in order to bring the real level of debt to levels that would reduce the very obvious vulnerability of the Irish economy.

One of the biggest problems with the income tax system is the fact that once a single worker earns over €34,550 per annum and a married couple with one earner earns €43,550, they pay the marginal tax rate of 48.75% on all earnings up to €70,044. This includes the PAYE rate, the USC and PRSI. This threshold was lifted by €750 to €35,300.

The second USC rate band was widened from €19,372 to €19,784. The 4.75 per cent rate of USC was reduced to 4.5 per cent. This will reduce the marginal rate of tax to 48.5 per cent for incomes up to €70,000.

The 9 per cent VAT rate was increased to 13.5 per cent for hotels, restaurants and hairdressers, but was left at 9 per cent for newspapers and sports facilities.

There is an increase of 50 cent on a package of 20 cigarettes.

There is no increase in the carbon tax.

The threshold for inheritance tax was increased by €10,000 to €320,000 for children inheriting from parents.

The earned income credit for self-employed was increased by €200 to €1,350.

The home carer tax credit was lifted by €300 to €1,500.

The weekly threshold for the higher rate of employer’s PRSI is being increased from €376 to €386.

The betting tax has been doubled from 1 per cent to 2 per cent.

VRT relief for hybrid vehicles will be extended until end of 2019.

A 1 per cent surcharge for diesel vehicles to apply across all VRT bands.

To encourage the uptake of gas-propelled commercial vehicles as an alternative to diesel a new accelerated capital allowances scheme for gas-propelled vehicles and refuelling equipment is being introduced.

Business and SMEs

A Future Growth Loan Scheme for SMEs and the agriculture and food sector is being launched and will provide up to €300 million.

Over €110 million for Brexit is being allocated across a number of Departments, including funding for essential customs requirements and a range of other targeted measures.

As part of the National Development Plan, a Disruptive Technologies Innovation Fund has been established, which makes €500 million available for co-funded projects involving enterprise and research partners over the period to 2027.

Extension to 3-year Start-Up Corporation Tax Exemption.

Significant changes to the Keep Share Option Scheme. Market value of shares granted goes to 100 per cent of salary with a lifetime limit of €300,000.

From 1 January 2019 there will be a 0.1 per cent increase (from 0.8% to 0.9%) in the National Training Fund levy payable by employers in respect of reckonable earnings of employees in Class A and Class H employments.

From 1 January 2020 there will be a further 0.1 per cent increase (from 0.9% to 1.0%) in the National Training Fund Levy payable by employers in respect of reckonable earnings of employees in Class A and Class H employments.

The main expenditure measures in Budget 2019 are:

There is an increase of €5 in social welfare payments.

The Christmas bonus payment will be fully restored to all social welfare recipients this year.

A new paid parental leave scheme will be introduced in November 2019 to provide two extra weeks’ leave to every parent of a child in their first year. The Government intends to increase this to seven extra weeks over time.

From March, the earnings disregard for the One Parent Family Payment will increase and a maintenance disregard for the Working Family Payment will be introduced.

The Qualified Child Payment of €2.20 per week in respect of under 12s and €5.20 per week in respect of over 12s, as well as a €25 increase in Back to School Clothing and Footwear Allowance rates.

The main housing measures are:

€1.25 billion has been allocated for the delivery of 10,000 new social homes through a combination of construction, acquisition and leasing.

An extra €121 million for Housing Assistance Programme (HAP).

An extra €60 million in capital funding, much of which will fund additional emergency accommodation and for additional family hubs.

€30 million is being provided for homelessness services.

€100 million for Serviced Sites Fund to support local authorities in bringing forward lands for subsidised, more affordable housing. This fund will be increased to €310 million over three years.

The planned funding is increasing from €20m to €89m, facilitating the delivery of around 6,000 affordable homes over the lifetime of the fund.

Mortgage interest relief for landlords will rise to 100 per cent.

The main health measures are:

An increase of €1.05 billion in Health funding for 2019 bringing the health budget to €17 billion.

€25 increase in the weekly income threshold for GP Visit cards

50 cent reduction in prescription charges from €2.00 to €1.50 for all medical card holders over the age of 70.

€10 reduction in the monthly Drugs Payment Scheme threshold from €134 to €124.

€84 million for Mental Health Services.

National Treatment Purchase Fund (NTPF) to get an extra €20 million.

€150m more for disability services bringing the total funding to €2bn.

The Rainy Day Fund

The Government will establish a Rainy-Day fund of €1.5 billion. The fund will be supplemented with an annual contribution of €500 million starting from next year.

The minister announced some of the “historically high levels of corporation tax” will be set aside for the fund.

While interpretation of Irish economic growth is very complicated and difficult due to the structure of the economy, it is clear that the real level of economic activity is quite healthy. However, there are a number of international threats and domestic challenges that should have been very influential in framing Budget 2019.

The possibility of higher official European Central Bank (ECB) interest rates later in 2019.

The stock of outstanding domestic credit is still high at 111% of GNI* and this creates a significant vulnerability to a sharper than expected tightening of international monetary conditions;

The ending of Quantitative Easing by the ECB in December 2018. This could result in higher government bond yields, which would gradually feed through to the cost of Government borrowing and the cost of servicing the outstanding level of Government debt.;

The growth of protectionism could damage global trade and economic activity. As a small open economy with a heavy dependence on external trade, Ireland would be very vulnerable to any slowdown in global trade and economic activity;

A hard Brexit. The Irish economy would be seriously undermined by a ‘hard Brexit’, but the indigenous sectors who have a strong trading relationship with the UK, would be particularly vulnerable. A ‘hard Brexit’ poses a particular challenge and creates a particular vulnerability for the rural and regional economies;

As the economy approaches full employment, wage pressures will inevitably build and labour shortages will become an issue across the broader economy. This will undermine the competitiveness of the economy and act as a constraint on its growth potential;

There is growing pressure to improve the quality and quantity of public services. This will inevitably increase the pressure on public expenditure. Given the still dangerously high level of public debt, tight control of public expenditure is vital to move towards a more sustainable fiscal situation.

Competitiveness is not a straightforward concept to define neatly as it encompasses a wide range of factors including all costs of doing business; the quality of public services such as health and law and order; the cost, quality and availability of housing; the physical and IT infrastructure; the tax environment; the quality of the labour force; regulation; the legal system, insurance costs, and all of the other factors that impact on the ability of an economy and every business in that economy to expand. Protecting the competitiveness of the economy is essential;

Recent trends in sterling give further cause for concern in relation to Ireland’s competitiveness. The sterling/euro exchange rate averaged 72.63 pence in 2015; 81.92 pence in 2016; 87.64 pence in 2017; and 88.41 pence so far in 2018. For Irish companies exporting to the UK, this represents a significant deterioration in the terms of trade over the past four years. It says something about the resilience and flexibility of such companies that they continue to trade successfully with the UK, but the challenge is a very real one and could become much more intense over the next couple of years.

The Summer Economic Statement released by the Department of Finance in June set out the economic and fiscal parameters that were expected to guide policy in Budget 2019.

At that stage, the Government planned to reduce the budget deficit to just 0.1 per cent of GDP in 2019, which was consistent with a budget day package of €3.4 billion. However, of this total, €2.6 billion was already pre-committed in the shape of €1.5 billion in extra capital spending through the National Development Plan; €300 million will be used up by the carryover effects of the measures introduced in Budget 2018; €400 million will be absorbed by public sector pay increases already committed to; and €400 million will be absorbed by extra spending on the back of demographic developments. This left around €800 million to be given away on budget day through a combination of tax changes and expenditure increases.

The parameters subsequently changed somewhat based on economic and fiscal developments. On October 5th, the Department of Finance published the Estimates of Receipts and Expenditure for the Year Ending 31 December 2019. The estimates of receipts and expenditure for 2018 in that publication were based on the Exchequer returns up to the end of September and the estimates for 2019 did not include the measures actually contained in the budget. The key point of interest for 2018 was an overshoot of €1 billion in corporation tax receipts, mainly due to once off accounting changes. This windfall, is basically being used to fund the over spending on health.

On budget day, the Minister for Finance announced tax increases that will raise €825.4 million in a full year and tax cuts that will cost €458.9 million in a full year. The net withdrawal in taxation was €366.5 million.

Following the budget measures, gross voted expenditure in 2019 will reach €66.6 billion, with gross current spending accounting for €59.3 billion of this.

The success or failure of any budget in terms of achieving its aims and objectives is heavily dependent on the economic environment. The economic forecasts underlying Budget 2019 look quite realistic, based on what we currently know about what is going on in the economy and the external risks that exist. Real GDP is projected to grow by 4.2 per cent in 2019, following growth of 7.5 per cent in 2018.

The increase in the VAT rate for the hospitality sector from 9 per cent to 13.5 per cent is the most noteworthy feature of a budget that granted generous increases in government expenditure. This expenditure is being funded by a sector that creates and sustains jobs all over the country and which faces a serious threat from Brexit. This move is difficult to understand.

Economic Forecasts Underlying Budget 2019

2018f

2019f

2020f

GDP

7.5%

4.2%

3.6%

GNP

5.9%

3.9%

3.3%

Consumption

3.5%

3.0%

2.6%

Investment

-8.9%

7.1%

5.7%

Exports

7.0%

5.6%

4.8%

Imports

0.9%

6.2%

5.3%

Employment (Average)

2,259

2,321

2,373

Unemployment Rate (Average)

5.8%

5.2%

5.0%

Inflation (Average)

0.7%

1.5%

1.7%

General Govt Deficit (% GDP)

-0.1%

0.0%

0.3%

General Government Debt (% GDP)

64.0%

61.4%

56.5%

Source: Department of Finance, Budget 2019

Tax Forecasts

Following the tax changes announced in the budget, overall tax revenues in 2019 are projected to expand by 5.2 per cent to reach €57.9 billion. Corporation tax receipts are projected to decline by 1.3 per cent, reflecting the once-off boost to revenues this year from changes to accounting standards. Income tax will account for 38.9 per cent of total tax revenues this year and 39.5 per cent in 2019.

The Irish economy continues to perform strongly. Quarterly National Accounts show that in the first six months of the year, GDP was 10.5% higher than a year earlier and GNP was 9.1% higher. Modified final domestic demand, which excludes the impact of trade in aircraft by aircraft leasing companies and trade in R&D and intellectual property, was 6.3% higher than a year earlier.

Consumer Spending

In the 8 months of 2018, the volume of retail sales expanded by 3.3% and the value of sales expanded by 2.1%. When new car sales are excluded, the volume of retail sales expanded by 3.7% and the value of sales expanded by 2.3%. The gap between the value and volume metrics is continuing to suggest price resistance from the stretched personal sector. Retailers are achieving strong business volumes but turning that volume growth into monetary value is still proving quite challenging. This implies continued pressure to control costs to preserve viable business margins.

In the first 9 months of the year, 123,099 new cars were registered, which is 4.2% lower than the first 9 months of 2017. The decline in new car registrations is occurring despite the very positive, and in theory, supportive economic backdrop for new car sales. In the first 9 months of the year 77,277 used cars were imported, which was 9.1% ahead of the first 9 months of 2017. Sterling weakness is the key driver of this trend, with 96.3% coming from the UK. Imported used cars are displacing new car sales and creating a challenging environment for the new car industry.

Consumer spending continues to steadily improve. However, there are two caveats. There continues to be a significant gap between the volume and value of growth in retail sales, and weaker new car sales are impacting on the overall retail sales numbers. These trends have been a feature of the retail market over the past couple of years.

Consumer Confidence

Consumer confidence has recovered strongly over the past three years but has plateaued over the past 18 months and is proving quite volatile from month to month. For example, in October, confidence dipped to a 21-month low. Issues such as Brexit, rapidly escalating house prices, higher fuel costs, the high personal tax burden, and subdued wage growth are combining to have a somewhat sobering influence on the personal sector. Despite the economic recovery, the personal sector is still quite fragile.

Consumer Confidence

Source: ESRI

Labour Market

In the year to June, the number of people in employment increased by 74,100 or 3.4% to reach 2.255 million. This is the highest level of employment on record. The level of unemployment declined by 26,800 in the 12-month period to September and the unemployment rate has fallen to 5.4% of the labour force. Since the weakest point of the labour market in January 2012, the number of people unemployed has declined by 226,600 from 356,000 to 129,400.

Tourism

The tourism performance continues to be very strong. In 2017, 9.93 million overseas visitors came to Ireland, which is the highest level ever recorded. The strong tourism performance has continued in 2018. In the first eight months of the year, 7.2 million overseas visitors came into the country, which is 7.8% ahead of the same period in 2017. Visitor numbers from Great Britain increased by 2.5% and accounted for 35.2% of total overseas visitor numbers. This is down from 40.9% in 2016. Sterling weakness has impacted on this market segment. The North American market expanded by 13.2%, and visitor numbers from the Rest of Europe increased by 10.5%.

Agriculture

2017 was a strong year for the farming sector. The operating surplus in agriculture increased by 30.9%. The output of milk increased by 44.7%, with the price of milk increasing by 32.6% and volume of milk output increasing by 9%. Livestock output increased by 4.4%. The prospects for 2018 do not look as promising. Adverse weather conditions in the spring created a serious fodder shortage, and record heat levels in the summer will damage grass production and create risks for fodder supply in the winter and spring. These factors will combine to increase input costs and undermine profitability over the remainder of 2018 and into 2019. The immediate future looks extremely challenging for the farming sector.

External Trade

Ireland continues to generate a strong surplus in merchandise trade, but there are some concerns. In the first seven months of the year, total merchandise exports were 11% ahead of the same period last year, with exports to the US increasing by 12.7% and to the Euro Zone by 16.7%. However, exports to the UK are down by 4.3%. Overall, the Irish trade story is strong, but the threat posed by Brexit is becoming more real.

The Housing Market

The housing market represents the biggest and the most immediate challenge facing policy makers. There is a shortage of housing for owner-occupier purposes and for rental purposes. This is manifesting itself in unacceptably high house price inflation and private rents. These trends will damage the competitiveness of the economy and act as a constraint on future growth potential.

The most up to date data on house prices show:

National average house prices declined by 55.2% between the peak of the market in April 2007 and the low point of the market in March 2013. Between March 2013 and July 2018, prices have increased by 81.3%. Prices in July 2018 were 10.4% higher than a year earlier;

In the Rest of Ireland (excluding Dublin), average house prices declined by 56.5% between the peak of the market in May 2007 and the low point of the market in May 2013. Between May 2013 and July 2018, prices have increased by 76.9%. Prices in July 2018 were 13.7% higher than a year earlier; and

In Dublin, average house prices declined by 59.6% between the peak of the market in February 2007 and the low point of the market in February 2012. Between February 2012 and July 2018, prices have increased by 93.8%. Prices in July 2018 were 7.2% higher than a year earlier.

The moderation in the annual growth rate is Dublin reflects affordability issues rather than an adequate increase in housing supply.

In the year to August 2018, private rents increased by 6.2% and have increased by 66.3% since the end of 2010.

The problem of escalating house prices and private rents reflects a lack of housing supply and strong natural demand for housing. Changes to the manner in which housing completions are calculated were recently announced by the Central Statistics Office (CSO) and they show that between 2011 and 2017, 53,578 new houses were completed compared to a previous estimate of 85,154. This demonstrates which the market is under so much pressure.

The Public Finances

The public finances continue to evolve in a positive fashion. Tax revenue buoyancy remains a feature on the back of strong economic growth, but the pressure on current government expenditure is intense.

In the first 9 months of the year the Exchequer recorded a deficit of €1,471 million. This compared to a surplus of €2,344 million in the first 9 months of 2017. Last year’s out-turn included the sale of AIB shares and when this is adjusted for, the Exchequer balance showed an underlying decrease of €381 million.

Total tax revenues came in €127 million lower than target. Corporation tax is putting in a particularly strong performance and is €306 million ahead of target. Income tax came in €8 million lower than forecast. Income tax accounted for 38.7% of total tax revenues in the first seven months of the year, which is down from 39.4% in 2017. Total tax revenues were 6.6% ahead of last year, which is equivalent to an absolute increase of €2.3 billion. Strong economic growth continues to generate strong tax revenues.

Total net voted expenditure was €2.9 billion or 8.9% higher than the first 9 months of 2017. Net current expenditure in the Department of Health was €301 million higher than profile and 7.2% ahead of 2017.